THE DUTY OF UTMOST GOOD FAITH

THE DUTY OF UTMOST

GOOD FAITH

Kelly Godfrey

Employment Lawyers

Increasingly Courts are implying a

common law duty of good faith into

commercial contracts. Requiring

parties to act honestly and

reasonably in exercising their

contractual rights, absent of

capricious or unconscionable

behaviour. 1Whilst the nature of the

duty of utmost good faith implied by

s.13 of the Insurance Contracts Act

7984 (Cth) ('the ICA') is different in

nature to that imposed by the

common law, it too is receiving

renewed interest. 2The doctrine of

utmost good faith in comparison

with other provisions of the ICA

remains somewhat of a mystery.

Whilst it is an area of insurance law

which has remained relatively

underutilised, the doctrine's

potential use makes it the great

unknown of modern insurance law. 3

The Scope of the Duty of

Utmost Good Faith

It is imperative that both the insurer

and insured participate in all

contractual negotiations,4 as the

duty of utmost good faith is a

reciprocal duty which relates to

every aspect of the parties

relationship.5 The duty endures until

all obligations underthe contract of

insurance have been discharged.

However, if the contract is

terminated by a release, the

subsequent behaviour of the parties

may be relevant. 6 lf a further

legitimate loss was discovered after

execution of the release, the duty of

utmost good faith would prevent the

release being pleaded as a bar to

the claim. 7 ln Australia, if litigation

is commenced in relation to the

policy, the duty continues until

judgement and perhaps beyond. 8

Defining the Duty of Utmost

Good Faith

The duty of utmost good faith,

(alternatively known as the duty of

uberrima fides 9) is better described

than defined. With the ICA providing

no definition, guidance must be

derived from an examination of the

parties' relationship on a case by

case basis. 10 Wh ilst the duty

requires an 'essential element of

honesty'll and 'good faith', arguably

the inclusion of the word 'utmost'

elevates the duty to a higher

status,12 requiring the parties to act

fairly and reasonably in accordance

with community standards of

decency and fair dealing. 13 It may

also require candour,14 utmost

fidelity, 15 the absence of

recklessness 16 and perhaps at its

highest, sacrificing a discretionary

economic advantage in

circumstances where its misuse will

be detrimental to the other party.17

It is not however, a fiduciary duty,

requiring one party to place the

needs of the other above its own. 18

A party to an insurance contract will

be prevented from relying upon any

provision in the contract where to

do so would constitute a breach of

utmost good faith. 19

An objective test, applied to the

subjective facts of the particular

case, is used to ascertain whether

the duty of utmost good faith has

been breached. That is, would a

reasonable person with the

subjective knowledge of the insurer

(orthe insured as the case may be)

take such action?20

Breach of the Duty of

Utmost Good Faith by the

Insurer

Whilst not an exhaustive list and

obviously based on the particular

factual circumstances pertaining to

the case at hand, the duty of utmost

good faith has been found to have

been breached where the insurer

has:

? failed to explain the important

provisions of the policy to the

insured;21

? failed to notify the insured of the

serious consequences of breaching

a condition of the policy;22

? failed to inform the insured of any

conditions which are precedent to

the insurer's liability to pay the

claim;23

AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #87 DECEMBER 2002 19

The duty requires the insurer

in certain circumstances to

discLose materiaL which may

be adverse to their case , as

weLL as provide the insured

with the opportunity to

address any matters upon

which the insurer has reLied

in making their

determination.

? failed to observe the strict terms

of the insurance contract;24

? relied on a term which had been

included in the policy in error;25

? failed to advise the insured that

the policy they had obtained did not

afford the protection they had

explicitly req uested ;26

? failed to progress a claim and to

make a decision on liabilitywithin a

reasonable period of time;27

? failed to provide an adequate

explanation for denying the claim

within a reasonable period of

time;28

? failed to make a settlement

payment on a legitimate claim

within a reasonable time;29

? failed to investigate a claim prior

to denying it;30

? failed to act reasonably and to

carefully assess the interests of

both the insured and insurerwhen

making the decision to defend

rather than settle the claim ;31

? failed to consult with and to make

proper disclosu re to the insu red

where there was a conflict of

interest between the parties;32

? failed to be candid and failed to

make clearto the insured at an

early stage the limits of any

obligations arising under the policy.

The insurer also failed to advise the

insured of differential liability, as

well as the risks the insured faced

and forwhich they may require

independent legal advice;33

? failed to act properly and

reasonably in assessing claims.

This obligation becomes more

onerous in circumstances where

the insurer is making a

determination in its own interests.

The duty requires the insurer in

certain circumstances to disclose

material which may be adverse to

their case, as well as provide the

insured with the opportunityto

address any matters upon which

the insurer has relied in making

their determination. 34

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AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #87 DECEMBER 2002

? failed to consult with the insured

in settling the claim and to explain

the consequences of the

settlement.

Whilst there is a 'quality of

confidence' between the parties

there is no disparity in the parties'

bargaining power 35

? declined the claim without

credible and genuine reasons.

Mere suspicion is not sufficient to

reject the claim. Nor is the insured

permitted to unmeritoriouslytest

the claim by putting the insured to

proof. 36

A breach of the duty may arise

where the insurer:

? fails to notify the insured of an

entitlement they have under a

policy of which the insured lacks

knowledge;37

? engages in 'horse trading',

something which is prevalent in

claims negotiations;38

? fails to draft the policy of

insurance in clear and

unambiguous language, so that the

insured clearly understands the

policy;39

? fails to disclose to the insured

pertinent information which would

have a substantive effect upon the

insured's decision to insure against

the risk;40

? without a valid reason, offers the

insured uncommercial conditions

on the renewal of a policy

attempting to dissuade the holder

to discontinue coverage;41

? delays payment of a claim to

secure an investment benefit;42

? makes an unreasonable and

unnecessary request for

information. 43

The Courts have held that the duty

has not been breached, in the

factual circumstances of the

particular case, where the insurer:

? accepted an increased premium

with the knowledge that an

exclusion clause in the policywas

likely to apply, in circumstances

where it had explained the

exclusion and given the insured the

chance to overcome it;44

? unreasonably refused to follow a

certain course of action;45

? maintained a bona fide defence

which ultimately failed ;46

? cancelled the insurance policy on

the basis of fraud after it had paid

the claim. 47

A breach will not necessarily be

found where the insurer refuses to

accept an attractive settlement

offer in an attempt to avoid adverse

publicity or to attempt to have the

insured share the liability.48

To a large extent these decisions

replicate the 'Ten Commandments

of Good Faith' which insurers in a

number of States in the United

States of America are required to

observe. Many States in the United

States have enshrined these duties

in statute. 49 These Commandments

require insurers to:

1. judiciously investigate claims;

2. efficiently evaluate claims;

3. inform the insured of all

settlement negotiations;

4. notify the insured of the likely

outcome of litigation;

5. forewarn the insured of the

possibility of a decision exceeding

the policy and counsel the insured

in relation to any action they could

take to avoid that occurrence;

6. conduct themselves having

regard to the interests of the

insured;

7. reasonably consider any

equitable offer of settlement and to

accept that offerwhere it would be

reasonably prudent to do so, given

the possibility of paying the total

indemnity;

8. furnish a legitimate defence and

to appeal any adverse decision

where good faith requires such

action be taken;

9. exercise care when providing a

legal defence;

10. use due skill and care when

adjusting claims. 50

The duty of utmost good faith may

restrain an insurer's ability to rely

on information obtained by its

agents, where those agents:

? prior to an indemnity being

obtained, gather information

without first warning the insured

that they are conducting

investigations without prejudice to

the insurer's rights; or

? without informing the insured that

such information may be relied

upon by the insurer in assessing the

claim. 51

Breach of the Duty of

Utmost Good Faith by the

Insured

Again, whilst not a definitive guide

and obviously based on the

particular factual circumstances

pertaining to the case at hand, the

duty of utmost good faith has been

held to have been breached where

the insured:

? deliberately provided a false

answer in a claims form;52

? in the case of a legal indemnity

policy, failed to advise the insurer

that proceedings had been initiated

against it and hence failed to

provide the insurerwith the

opportunity to assume conduct of

the matter;53

? intentionally withheld information

in making a claim, intending to

deceive the insurer;54

? failed to act reasonably so as to

reduce or minimise the insurer's

liability;55

? failed to provide information

required by the insured and

required by the terms of the

policy;56

? knowingly made a fraudulent

claim. 57

AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #87 DECEMBER 2002 21

Other circumstances in which a

breach of the duty may be found

include:

? failure to notify the insurer of

circumstances which may effect the

insurer's future conduct with

respect to the policy,58 in

circumstances where there is an

enduring contractual obligation to

do SO;59

? recklessly completing a claims

form ;60

? an exaggeration of the

circumstances pertaining to a

claim;61

? engaging in 'horse trading' to

settle a cla im ;62

? failure to provide information to

enable the insurer to make a

decision on indemnity.63

It is unlikely that a breach of the

duty will be found where the

insured:

? fails to disclose their precarious

fin an cia l posit ion;64

? provides information which does

not fully disclose all necessary

issues, in circumstances where the

insurer neglects to request

additional material. 65

Courts have held that the duty has

not been breached on the specific

factual circumstances of the case,

where the insured:

? in accordance with legal advice,

withheld information in an effort to

secu re assista nce from the

reinsured's underwriting agent;66

? failed to disclose that they had

double insurance;67

? failed to declare property covered

by the policy in a declaration of

value clause;68

? made a bona fide claim and

instituted court proceedings when

the claim was denied by the

insurer;69

? elected in accordance with legal

advice, not to notify the insurer of

circumstances which may give rise

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AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #87 DECEMBER 2002

to a claim, due to the likely effect

on future premiums;70

? failed to notify the insurer of

information which was discovered

only after the claim had been

settled and the contract terminated,

in circumstances where there was

no continuing obligation to do SO;71

? had increased the potential

liability of the insurer, by acting in

accordance with legal advice and

electing to rescind an earlier

settlement agreement and enter

into a new one which provided for

the assignment of the insurance

contract for an additional year;72

? made an innocent error in

completing a claim form;73

? used the formula provided in the

policy to calculate the amount

payable, in circumstances where

the method produced an inane

resu It. 74

Insurance brokers do not

themselves owe the insurer a duty

of utmost good faith. However, as

the insured's agent, they must be

extremely careful not to breach the

insu red's duty by thei r actions. 75

REMEDIES FOR BREACH OF

THE DUTY OF UTMOST

GOOD FAITH

Bad Faith Claims and

Punitive Damages

Bad faith claims are prevalent in

the United States. It is based on the

premise that insurance is obtained

for peace of mind, which has seen a

flurry of litigation and an expansion

of the concept beyond Australian

standards. 76 This covenant of good

faith and fair dealing obliges the

parties to avoid any action which

may harm the rights of the other to

secure the benefits of the

contractual bargain. 77 ln the United

States, a breach of the duty may

give rise to both contractual and

tortious liability, resulting in not

only compensatory and punitive

damages but also damages for hurt

feelings and emotional distress. 78

Whilst some US courts have

indicated that there should be a

reasonable relationship between

the award of punitive and

compensatory damages, there are

no prescribed limits. In determining

the quantum of the award some US

cou rts have gone to the extreme of

allowing evidence of the insurer's

financial position to be tendered.

The State of California has

consistently made the highest

awards, with punitive damages

sometimes 200 times the

compensatory damages award.

Some US courts have also

indicated a willingness to award

punitive damages in cases where

compensatory awards are denied.79

The evolution of bad faith damages

in New Zealand has been short

lived with the New Zealand Court of

Appeal overturning the High Court's

decision to award bad faith

damages in Cedenco Foods Ltdv

State Insurance Ltd. 8o The High

Court in making the award indicated

that whilst the payment of interest

went some way toward providing

appropriate compensation, the

'outrageous' failure of the insurer to

promptly pay the valid claim

justified sanction byway of punitive

damages, intended to punish the

insurer. 81

Whilst the Australian Law Reform

Commission ('theALRC') has

declined to introduce a tort of bad

faith into the ICA, asserting that

contractual remedies are

sufficient,82 the courts have at least,

in circumstances where the

insurance contract is not subject to

the ICA, indicated the potential for

the existence of a tortious duty.83

Whilst awards of punitive or

exemplary damages are rare, often

confined to intentional torts such as

defamation and trespass,84 it

appears that Australian courts are

becoming less conservative in their

approach. 85

Theoretically damages exceeding

the limits of the insurance policy

are possible. If an insurer

unreasonably declines to settle a

matterwithin the limits of the

policy, resulting in a determination

exceeding policy limits, ordinary

contractual principles should

permit a compensable award of

damages, which may exceed policy

limits. 86 It is possible that punitive

damages may also be imposed

where an insurer demonstrates a

callous disregard forthe interests

of the insured or systemically

breaches the policy. Whilst s.13 is

likely to play an ancillary role in

such circumstances, (the action

likely to involve a breach of other

terms and conditions of the policy),

the very existence of the duty of

utmost good faith may increase the

likelihood of such an award. 8?

In Gibson v The Parkes District

Hospita{88 Badgery-Parker J

examined the duty of good faith in

the context of a workers

compensation policy, not subject to

the ICA. However, His Honour's

reasoning could equally be applied

in the context of claims arising

under the ICA. His Honour held that

the insurer had breached its duty of

good faith in failing to process and

pay the claim within a reasonable

period of time and that this breach

attracted liability for damages in

tort, given the proximate

relationship between the parties,

characterised by 'dependence and

vulnerability' .89 His Honour

indicated that the damage suffered

by the insured went well beyond

that which the workers

compensation scheme could

remedy. He indicated that the

insurer's conduct had the potential

to cause not only 'temporary

hardship, anxiety and distress, but

also in some cases ongoing

economic loss; as where during the

period of delay the worker is unable

to maintain mortgage or hire

purchase payments and suffers

forfeiture or is forced to sell

assets' .90 For this the worker must

receive adequate compensation.

AUSTRALIAN CONSTRUCTION LAW NEWSLETTER #87 DECEMBER 2002 23

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